The Housing Mirage

It's getting harder to see how much longer the housing market will continue to drop before hitting bottom

Like a mirage in the desert, the bottom of the housing slump seems to fade in and out of sight as the year progresses. Home sales jump, and there—you think you can make it out in the distance. Home sales fall, and it's lost in the haze.

"There's a lot of competition trying to figure out when things are going to bottom," says Morningstar (MORN) analyst Eric Landry. "But it's unlikely that you're going to figure that out before any one else does."

In the last week of June, at the very end of what are traditionally the strongest three months for home sales, we learned that both existing- and new-home sales remained sluggish in May. On June 25, the National Association of Realtors said the rate of existing-home sales slipped 0.3% in May, to an annual pace of 5.99 million units, while supply climbed to 8.7 months, the highest reading since June, 1992. The next day, the U.S. Census Bureau said sales of new single-family homes fell 1.6% in May, to a seasonally-adjusted annual rate of 915,000 units. New-home supply edged up to 7.1 months from 7 months in April.

Price Cuts Aren't Cutting It

The May home sales news, combined with homebuilder Lennar's (LEN) weaker-than-expected earnings announcement on May 26, dashed any remaining hopes of an imminent end to troubles in the housing market. Spirits had been higher in April, when sales of new homes jumped 13%, as builders whittled away at huge inventories with aggressive pricing. The median price of a new home dropped 11% in April from the previous month, to $229,100, the biggest decline since 1970.

But for homebuilders, price cuts just aren't cutting it anymore. Lennar, the second-biggest builder in the country, reported a second-quarter loss of $1.55 per share, down from a profit of $2 one year ago, and much lower than analysts' forecast of a 5-cent-per-share profit. The Miami builder said lower prices helped move inventory, but backfired on profit margins. "As we look to our third quarter and the remainder of 2007, we continue to see weak, and perhaps deteriorating, market conditions," Chief Executive Stuart Miller said in a statement (see BusinessWeek.com, 6/26/07, "Housing Woes Hammer Lennar").

Landry still likes the troubled builder. "It was a very, very, very bad quarter for Lennar," he says. "But there are a lot of things happening below the surface that longer-term investors will appreciate." Lennar has taken the steps to prepare itself for a housing correction by maintaining a strong balance sheet and cutting land inventory before other builders, Landry notes. And at its current price, it's a good deal, he says, and it's well-positioned to make a comeback after the market picks up.

Buyers on the Sidelines

Of course investors are still wondering when that might happen. "Write it off: '07 is going to be a bad year," Landry says. "It [the housing bottom] could be a 2008 event, it could be a 2009 event." To make matters even more confusing, it may be difficult to draw any strong conclusion from May home-sales data, given the very small month-over-month declines. This is especially true for new-home sales, which have a margin of error of 10.8%. "The housing market data, especially new-home sales, is historically extremely volatile, " says Wachovia (WB) analyst Adam York. "If you get a lot of sales one month, there's an extremely good chance you won't get as many the next month."

As mortgage rates creep up, subprime problems proliferate, and buyers stay on the sidelines, the outlook for housing is bound to become more and more uncertain. In addition to new-home sales, housing starts increased in April, and both declined in May. "Perhaps people had been hoping that the bottom had come and gone last month," says York. "We're still pretty much saying that the bottom is going to be this year, but we may not have seen it yet."